Can Gold add glitter to your Portfolio?

In our series on building high return, low risk portfolios, we have learned that an asset class can be of value to our portfolio if it add to the return, or if it is sufficiently uncorrelated to the rest of the portfolio to reduce the risk without reducing the returns.

One common piece of investment advice is to add precious metals, often specifically gold, to your portfolio as a way to hedge or reduce the overall risk of the portfolio. The rationale, of course, is that gold often moves in the opposite direction of the overall market, as when there is a great deal of uncertainty, or the fear of inflation, or even something as severe as the threat of war, then gold will often move up in value.

It turns out that there are a couple of ways for us to participate in the gold market. First, there is the Fidelity Select Gold fund, we can use in our Fidelity funds accounts. While this fund does not invest directly in holding gold, it does invest primarilly in gold mining stocks and other related stocks, so tends to track the gold market reasonably well.

A couple of options for our ETF portfolio are some of the gold ETF's. This includes GLD and IAU.

To test the performance improvement from adding gold to our portfolio, we took a look at our final hedged portfolio. Recall it consisted of the following allocations:

28.6%  Fidelity Seasonal System (FID4L)
28.6%  Fidelity Select System  (FIDO2)
14.3%  Fidelity Real Estate Fund  (FRESX)
14.3%  Fidelity Select Health Care Fund  (FSPHX)
14.3%  Profunds UltraBear  (URPIX)

Since we had originally tested this over the 1995-2005 time frame we used the Fidelity Select Gold fund for our portfolio, since it was in existence over the entire time frame.

We slightly shifted the allocations to create a 12% postion in the gold fund, so the allocation was:

25.0%  Fidelity Seasonal System (FID4L)
25.0%  Fidelity Select System  (FIDO2)
12,5%  Fidelity Real Estate Fund  (FRESX)
12,5%  Fidelity Select Health Care Fund  (FSPHX)
12,5%  Profunds UltraBear  (URPIX)
12,5%  Fidelity Select Gold (FSAGX)

The results were as shown below, with the previous portfolio preformance shown for comparison.

	Portfolio Rtn w/ Gold	Original Portfolio Rtn
2005	16.45	13.37
2004	11.18	13.89
2003	20.29	17.79
2002	20.14	13.77
2001	3.34	5.91
2000	25.91	33.4
1999	20.91	20.87
1998	19.13	20.09
1997	3.23	9.77
1996	17.58	17.27
1995	18.69	18.14
Std Dev	7.240	7.095
MDD	9	8.2
Total	16.1	16.3

As you can see, there was no improvememt in the portfolio performance. If you look at the average annual return, the standard deviation of annual returns, the maximum drawdown, of the lowest annual return, they are all worse with the gold fund in the portfolio. This in spite of the fact that the test period included 2000 to 2002, as bearish a period as we've seen in decades. It also includes the bull run in the Select Gold fund in 2003 (up 90%) and 2005 (up 100%).

In summary, it's hard to point out a significant performance gain to be found by adding a gold allocation to your portfolio. Conversely, it doesn't really degrade it much either, so in this case it's probably a matter of personal preference.